What solar companies will survive the solar winter to profit from the solar spring--and when do you want to own them?

11/15/2011 8:30 am EST


Jim Jubak

Founder and Editor, JubakPicks.com

It would be a plot worthy of Bond villains Auric Goldfinger, Ernst Blofeld or Francisco Scaramanga—destroy the world’s solar industry by providing cheap capital and demand-creating subsidies so that solar companies over expand, and then pull the plug on capital and subsidies so that the industry goes bankrupt.

Except that this is the real world and nobody needs Scaramanga to steal the Solex Agitator, the MacGuffin essential to solar energy production in the fictional world of The Man with the Golden Gun. In the real world well-meaning governments, financial markets, and the solar industry can do the damage all by themselves.

The price of polysilicon, the raw material for conventional solar sells, has dropped by 56% this year to level not seen since 2003 and by 93% since 2008.

And yet, if all the factories now under construction or on the drawing boards get built, global supply of polysilicon will climb to 500,000 tons by 2014 from 266,000 tons in 2011.

The average margin at the companies that turn polysilicon into solar cells (or that use other technologies for producing photovoltaics) fell to 0.1% in the third quarter of 2011 from 13.7% in the third quarter of 2010.

And yet, the 10 largest makers of silicon panels doubled their manufacturing capacity last year.

It’s no wonder that Jifan Gao, CEO of Trina Solar, China’s third-largest producer of solar panels, said in a recent interview with Bloomberg that two-thirds of the players in the industry will go bust or be acquired between now and 2015. A recent report from Australia’s Macquarie Securities gave a similar number: 66% of polysilicon producers would fall victim to the shakeout that has just begun. For example, in China the sector would be reduced to as few as four players over the next three years from 35 known producers today. Further down the supply chain, the companies that manufacture solar panels are facing a similarly disastrous near-term future. The spot price of solar panels has tumbled 40% this year. Q-Cells, once the world’s biggest maker of solar cells, has said it’s open to a takeover.

And yet—this looks like the solar winter that comes before the solar spring. The drop in the price of polysilicon—which makes up about 25% of the cost of a finished solar panel—intense price competition among solar companies, and improving efficiencies in manufacturing and in the efficiency with which solar panels convert sunlight to electricity all say that the elusive goal of price parity between solar-generated electricity and electricity from coal, oil, natural gas, and uranium is in sight without the need for a high-powered telescope. Exactly when is a matter of intense argument and speculation, but in some place—those with lots of sunshine and higher costs for electricity from other sources—price parity could come as early as 2015.

Installed global solar capacity was 36 gigawatts at the end of 2010, according to the U.S. Energy Information Agency. By the end of 2020 global capacity will be 20 to 40 times that level—or 720 to 1,440 gigawatts, consultants McKinsey &Co project. Investment banker Piper Jaffray expects growth to a global installed capacity of 800 gigawatts by 2020.

Whoever gets through this winter will make a lot of money come solar spring.

So how do you want to play this as an investor?

I think you’ve got three choices. First, you can wait until 2013 or 2014 or perhaps even 2015 to see who has survived and buy those shares then. That has the advantage that you’ll know who got shook out during the shakeout and who is now in a position to profit from the turn in the market. Second, you can buy a portfolio now of solar companies that look like they’ll be survivors in the belief that your winners will win big enough to make up for your losers. That’s the kind of strategy that investors in high-risk areas such as venture capital pursue. It has the advantage of staking your claims now when prices are depressed but it has the disadvantage that you could pick a portfolio full of turkeys and still miss the upside even though you’re diversified. Or third, you could combine those two strategies and wait for the shakeout to progress for a year or two and then buy a portfolio of likely survivors.

I’d vote for No. 3.

But no matter which of the three you decide to pursue you’ll need two things—a method for deciding what companies are likely survivors and a method of deciding which companies will be likely to profit—and therefore which you’d like to own--come the transition from solar winter to solar spring.

Want to gage a solar company’s survival chances? Look at its financial strength. That more than any technology or manufacturing edge will determine what companies are still standing in 2015.

That’s because 2011 and 2012—at the least—look so grim. The world saw 23 gigawatts of new capacity installed in 2010, according to SMA Solar Technology. (As the leader in the photovoltaic inverter market, SMA has a good take on industry trends.) In 2011 that new capacity looks like it will drop to 19 gigawatts to 21 gigawatts. 2012, the company says, will see modest if any growth from 2011 levels. Those projections make sense if you consider that some of the countries with the most generous subsidies for solar power—Italy, Germany, and Spain--are exactly those countries at the center of the euro debt crisis and the slowdown in European economic growth.

Now this drop in the growth of new installed solar capacity wouldn't be too bad except—remember—that the industry has so much new manufacturing capacity coming on line. With demand dropping and capacity growing, we’re looking at a price squeeze in the fourth quarter of 2011 and in 2012 that will make the hair-thin average operating margins in the third quarter of 0.1% look like the good old days. If half of the solar companies were running operations in the red in the third quarter, imagine the blood bath this quarter. And in quarter after quarter in 2012.

The damage won’t be spread evenly around the industry either. Already we’re seeing sales flow toward the biggest players in the industry—those that customers can count on to be there even if times get even tougher. Nobody wants to plan a solar project and then have suppliers go bust. For instance, the top six manufacturers of solar panels took 55% of the market in the second quarter of 2011, according to China’s Suntech Power Holdings (STP). That was up from 26% in 2010.

In this environment I’d have to have a really, really good reason to invest in any company outside the top 10 in its sector. Or any company that was highly leveraged. My preference would be for companies with big market shares and deep pockets.

So I’d cast a dubious eye on companies like China’s LDK (LDK), the world’s second largest maker of silicon wafers used in solar panels, and Canadian Solar (CSIQ), a maker of solar panels, that show twice as much short-and long term debt as shareholder equity, according to Bloomberg.

But I go beyond balance sheets in my due diligence to look at whether or not a company has a way to tap deep pockets in order to survive. An example of what can happen even to the biggest of solar players is the fate of Conergy (CEYHF), once Germany’s larger manufacturer and installer of solar panels, which was taken over by its creditors in July.

Solar companies with deep pockets behind them include SunPower (SPWRA)--French oil company Total (TOT) acquired a 60% stake in June—Hemlock Semiconductor--the world’s biggest maker of polysilicon, which is owned by Dow Corning (itself owned by Dow Chemical (DOW) and Corning (GLW)), and Japan’s Shin-Etsu Handotai and Mitsubishi Materials—and Chinese players such as Suntech Power Holdings, Yingli Green Energy Holding (YGE), and Trina Solar (TSL).

Individually these Chinese companies have the scale that I think you want to own in this sector. Suntech is the world’s largest solar maker of solar panels by manufacturing capacity, for example, according to EnergyTrend. Trina is No. 3 and Yingli Green Energy is No. 4.

And collectively China has the world’s deepest pockets. The country has flagged solar energy as a key engine of economic growth for the next decade and has committed government funds to make that happen.

But that doesn’t mean we know which Chinese companies will get the government’s backing through this shakeout.

Here’s where a strategy of waiting for 18 or 24 months or more pays an extra dividend. Right now it’s very hard to tell which of China’s sector leaders will come through the shakeout in the best shape and which ones might be cut loose by Beijing. For example, Suntech Power on November 9 announced that it expects shipments in the third quarter to growth by 15% from the second quarter and for gross margins to climb from an earlier forecast of 11% to 13% to 13%. Great performance when the company’s Chinese competitors have cut forecasts for shipment volumes and margins. But just about no one on Wall Street expects that the company can find a way to cut costs and expenses fast enough to escape the global downturn.

I’d sure like to see what the numbers look like in another quarter or two. And with trends going in the direction they are, I don't feel any great need to rush into action before I’d seen what those quarters look like.

But building a post-solar winter portfolio isn’t all about deep pockets and market share. This is, after all, still a very new and fast developing technology and I think it’s worth adding a few of the companies that are pushing the technology and manufacturing envelopes in the sector even if they don't have as much market share or as deep pockets as the companies above do. It I had to pick companies that fit this description to add to this solar portfolio now I’d pick First Solar (FSLR), a leader in thin film technologies that show the promise of beating the costs of silicon-based solar cells in the long-run, and SunPower Technology, which is pushing the sunlight into electricity efficiency barrier as fast as anyone in the sector.

So if I were to pick a solar portfolio now I’d pick Suntech Power, Yingli, Trina, First Solar and SunPower.

But, let me remind you, I’m not picking a portfolio today. The solar winter is likely to run on for a while and the solar industry could look much different by the time its over. I’d advise staying flexible enough to change the membership of that portfolio as the trend plays out.

To judge the progress of that trend—and to decide when I want to buy this portfolio—I’d watch something called price parity. Price parity is the point at which solar-generated electricity costs the same as electricity generated from other sources such as coal or nuclear. Price parity is what will determine when we’ll see a big explosion in demand for solar cells and panels and when you want to put some money into this sector.

Unfortunately, price parity isn’t simple to figure. It depends on the where—because it depends on how often the sun shines and on the cost of other local sources of energy—on the what—because it depends on what subsidies governments provide for solar, coal, natural gas, and other forms of electricity production and whether they get counted in the calculations—and on the who—because who calculates parity determines the results of the calculations.

Fortunately, you don’t need to descend into that morass. Instead you can use the predictions of when parity will arrive by one group or another to see how we’re progressing against expectations. Pick a group that does solid work, that’s relatively mainstream in its opinions (although it’s okay if it’s a mild advocate or opponent of solar power), and that’s likely to be around for the next decade.

So you might pick the projections of the European Photovoltaic Industry Association. The group isn’t exactly neutral but their work is founded on reasonable assumptions and is widely reported. The organization is projecting that solar-generated electricity will reach price parity—they’re actually talking about grid parity, which is parity in the price of electricity paid by retail consumers--in Italy, Spain, Germany, and France by 2015.

Watch to see if that projection changes in the group’s annual reports and time your solar portfolio accordingly.

And what do you do if you already own a solar stock or two? Of course, you can hold them for the turn in 2013 or so. That’s a long time to sit on dead money. Or you can look for a rally that will let you sell now to buy another day. That’s an especially appropriate idea for Chinese solar stocks that have been pounded with the rest of the Chinese stock market but now look to be making up some ground with other Chinese stocks. So, for example, you might want to hold onto shares of Yingli Green Energy to take advantage of more of that general market trend before selling. That's what I plan on doing in my Jubak’s Picks portfolio http://jubakpicks.com/ where I hold Yingli Green Energy. (I also hold First Solar and SunPower in my long-term Jubak Picks 50 portfolio http://jubakpicks.com//

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Yingli Green Energy as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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